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QIC The View 0209indd

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The View
A quarterly publication from QIC - February 2009


In this edition                                 Portfolio rebalancing                           ESG Update
Liquidity challenges for                        An old concept with significant                  Encouraging long-termism
superannuation funds                            benefi ts in volatile markets




Message from Doug
                   In my first message           While these conditions will put further         However, when all consumers stop
                   for 2009 I would have        pressure on equity markets and result           spending we have what Keynes called
                   liked to convey more         in the continuation of poor short-term          the “paradox of thrift”. As spending
                   optimism, however, to        investment returns, the key risk that needs     declines, sales fall, corporate profits dry
                   do so would mean I was       to be managed is counterparty risk. On          up, business confidence falls and business
                   being less than frank with   that front I remain confident that Troy          investment and industrial production
                   my views and analysis of     Rieck and our Capital Markets team have         contracts. Employment is highly correlated
                   the current situation.       implemented all possible safeguards. The        with industrial production, and therefore
                                                team is a recognised leader in liquidity and    employment also contracts. Consumers
While it is generally accepted that the         counterparty risk management, including         who were cautious are unhappy that
global economy will get worse before it         the effective use of Credit Support             they are in the midst of a recession, but
gets better, I fear that we are also likely     Annexures (CSAs). You can read more             are pleased they have been prudent
to experience another shock to the              about liquidity management in the article       – collectively their expectations have
financial system, or what I am calling the       ‘Liquidity challenges for superannuation        been self-fulfilling.
‘third wave’ of the financial crisis (the        funds’ on page 3.
first wave was caused by initial liquidity                                                       The cycle is reversed when the flow
concerns and the second occurred as             Post crisis – what will we be left with?        of bad news lessens and consumers
illiquidity morphed into insolvency). We        In such dire and extreme conditions it is       cautiously re-emerge. I expect and hope
will experience a third wave because            easy to lose sight of the end game. In an       that this will occur in the second half of
those institutions that have survived to        uncertain environment characterised by          2009 and, if it does, recovery should be
date, with the assistance of generous           significant reductions in individual wealth,     relatively swift. However, many pundits
global taxpayers, are not in a condition        low job security and rising bankruptcies,       are much more pessimistic and expect a
to weather the increase in bad loans            it is not surprising that all of our thoughts   longer and weaker recovery.
normally associated with the onset              are on the here and now. However, in
of a recession.                                 order to emerge from the current crisis         The global economy that will eventually
                                                as quickly as possible and to make the          emerge will have a much smaller financial
The willingness of governments, read            best of opportunities as they arise, it is      sector, fewer structured products and a
taxpayers, to bail out these institutions       important that we keep an eye on the            greater appreciation for risk management.
will be tested, and even if rescue packages     likely longer-term scenarios and outcomes.      Inevitably we will have more regulation
are forthcoming, confidence in various                                                           – both good and bad.
markets will again be severely tested. In       For me, the most likely scenario is that
particular, the subsequent heightened           during the first two quarters of this year       As for investment returns, the question
risk that a large financial institution (and     will see a continuing spiral into global        that remains is just how much bad news
a major counterparty to many) may fail          recession. The primary cause, over and          is currently priced in? If we use the US
will cause major disruptions to inter-bank      above the issues associated with the            stock market as an example, the S&P500
lending, cash and credit markets.               credit squeeze, is the fact that globally,      to date has experienced less than 4%
                                                consumers stopped spending in the               compound annual growth since 1995.
These markets are far from liquid at            second half of last year. I believe this        With inflation growing at 2.5% per year,
present and are a significant restraint to       decision was, individually, largely voluntary   equity prices, adjusted for inflation, grew
economic activity. An additional shock          and a precaution against the bad news           more slowly than real output over the 13
will further delay the ability of the           emanating from financial markets.                year period. This suggests to me that a lot
global economy to begin the process                                                             of bad news is currently priced in.
of recovery.                                                                                                           Continued on page 2

Brisbane Sydney Melbourne London                                                                                             www.qic.com
Message from Doug (continued)


With this in mind, it is much easier            I hope you enjoy this latest issue of ‘The       I would appreciate any feedback, questions
to consider attractive investment               View’. Though not a very cheerful one,           and challenges you have for me and the
opportunities in the current climate.           our aim is to keep you well informed             QIC team. Please send them directly to
However, while most asset prices are            about conditions and developments in             me at d.mctaggart@qic.com.
depressed at the moment, it is important        investment markets. Ongoing and open
to be prudent, selective and disciplined to     dialogue is even more important during
ensure the asset can negotiate the current      these difficult times. Where we can, we
crisis and deliver strong long-term returns.    are always willing to help you overcome          Doug McTaggart
                                                any challenges that you are facing. As usual,    Chief Executive




Economic and market snapshot
The global economy has deteriorated             of GDP) over the coming two years.               in commodity prices and the terms of
sharply over recent months and it is likely     A number of other major advanced                 trade are undermining the outlook for
that during 2009 it will record its weakest     economies have also announced fiscal              investment and exports, particularly in
outcome since WWII. In response, policy         packages generally around 1 to 2% of             the mining sector. However, significant
makers have stepped up their efforts            GDP. While these packages will be a              monetary and fiscal stimulus is in the
to arrest the slide in economic activity.       positive development for the global              pipeline, with the government announcing
The US and Japanese central banks have          economy, our research indicates that they        a $A42bn fiscal package worth around
already taken their effective cash rates        will not prevent a severe global recession.      3.8% of GDP to be spent over the next
to zero, and although the central banks         We expect the global economy will grow           four years and the Reserve Bank lowering
of Europe and the UK appear more                at around 0.9% in 2009, led by a sharp           cash rates to 3.25% . Our preliminary
reluctant, we expect that they too will be      contraction in the advanced economies.           analysis indicates that the fiscal package
forced to lower their cash rates to zero        The advanced economies will, on average,         will boost growth by around 1% in 2009
by the second half of the year.                 contract by around 1.2% in 2009, the first        and 0.5% in 2010. Nonetheless, given the
                                                year the advanced economies will have            current weakness in the global economy,
With the scope for further support from         collectively recorded negative growth in         the fiscal stimulus is unlikely to prevent
monetary policy fading, governments             the post-war period.                             the Australian unemployment rate from
around the world have been formulating                                                           rising to around 7% by the end of 2010.
fiscal stimulus packages to boost                The outlook for Australia has also
economic growth. In the US, it looks likely     deteriorated markedly following a sharp
that President Obama will implement             slowdown in growth in China and the
a package of around $US825bn (5.8%              rest of the Asia region. The collapse

 QIC Forecast             Australia                                US                                      Europe

                          Current     Jun-09   Dec-09              Current   Jun-09     Dec-09             Current   Jun-09    Dec-09

                          3.25%       2.50%    2.50%               0.00%     0.00%      0.00%              2.00%     0.00%     0.00%

                          2008        2009     2010                2008      2009       2010               2008      2009      2010

                          2.4%        0.8%     2.0%                1.1%      -1.2%      2.3%               0.9%      -1.8%     1.0%




QIC Real Estate – Toowoomba Shopping Centre purchase
QIC has expanded its property portfolio         for a contract price of $30 million,             The property complements our existing
in south-east Queensland with the               which represents a market yield of 8.8%.         asset in the Toowoomba retail market,
strategic acquisition of Gardentown             Settlement occurred on 19 January 2009.          Grand Central Shopping Centre, and
Shopping Centre, its second shopping                                                             presents an excellent opportunity to
centre in the Toowoomba region.                 The acquisition reflected QIC Real Estate’s       introduce new retailers to the region.
                                                focus on identifying strategic long-term
The 16,098 square metre retail precinct         investment opportunities.
was purchased from the Aspen Group
Liquidity challenges for superannuation funds
Troy Rieck, Managing Director, Capital           eroding performance. The unacceptable               For more information about how you can
Markets, explores this increasingly              alternative would be to unwind the asset            protect your fund from the significant risks
important issue of liquidity management.         allocation of the fund, leaving it exposed          associated with insufficient liquidity, while
                                                 to a significantly higher risk of being              also managing your market exposures,
For many years superannuation funds              unable to meet its long-term objectives.            contact your QIC Relationship Manager
have benefited from a continuous stream                                                               or download the full Red Paper from the
of inflows as a result of Superannuation          To avoid these scenarios, funds need to             Knowledge Centre at www.qic.com. Also
Guarantee (SG) contributions, and this           understand the potential liquidity needs            have a look at the article on portfolio
ready supply of cash has meant that many         of their fund and their exposure to a               rebalancing on page 4, which further
funds may not have fully considered the          range of risks that may impact on liquidity.        explores how funds can reduce risk in
risks associated with illiquidity.               In addition, they need to consider how              volatile markets.
                                                 liquid the various assets and strategies are
Recent market events however have                that they invest in. Once this information
clearly illustrated the effects of paying        is known, appropriate strategies can be
too little attention to liquidity and risk       implemented to manage those risks.
management. Equity markets have crashed,
the Australian dollar has depreciated            QIC believes that liquidity should be a key
significantly, credit markets have imploded       consideration in all investment decisions.
and hedge funds and commodities haven’t          Further, funds should employ a range of
provided the promised diversification             strategies to monitor and mitigate liquidity
of risk that funds badly need. These             risk, including detailed contingency and
conditions, together with increased              scenario planning, frequent rebalancing
member movement and greater                      strategies and maintaining a suitably large
allocations to unlisted assets, have meant       pool of cash assets to meet the fund’s
that some funds are now facing serious           short-term liquidity needs.
liquidity issues.
                                                 An efficient way to handle this challenge
The liquidity of an asset relates to             is to embrace the ability to separately
how quickly and efficiently it can be             manage the capital allocations and asset
converted to cash. Liquidity is critical         class exposures of the fund. In this way,
for funds to pay member benefits,                 funds can achieve their desired asset
fund future commitments and maintain             allocations while proactively managing
their derivative overlay programs. If a          their liquidity needs.
fund does not have enough available                                                                                     Troy Rieck
cash, it may be forced to sell assets            It is possible to have your liquidity cake                             Managing Director
at significantly deflated prices, further          and to eat market performance too.                                     Capital Markets




Financial market snapshot
 Key Market Indicators (as at 31 January 2009)     FYTD              1 Year               3 Year               5 Year           10 Year

 Australian Shares                               -30.4%              -34.3%               -6.6%                 6.0%               6.2%
 International Shares (Unhedged)                  -10.1%              -19.4%               -7.7%                0.3%              -2.2%
 International Shares (Hedged)                   -36.8%               -39.1%             -12.3%                -1.4%               -1.1%

 Australian Bonds                                 13.6%              15.2%                 7.5%                 7.1%               6.3%
 International Bonds (Unhedged)                   51.4%              42.2%                13.1%                 8.7%               5.2%
 International Bonds (Hedged)                      9.4%               9.8%                 7.7%                 7.6%               7.2%

 Direct Property (Australia)                      -6.3%               -4.8%                9.7%                10.9%              10.1%
 Listed Property (Australia)                     -40.2%              -51.7%              -19.8%                -5.5%               1.7%

 Inflation (CPI)                                         -              3.7%                   3.3%              3.1%               3.1%
   ESG Update – encouraging long-termism
   QIC is currently determining how we                                        new UNPRI signatory (January 2008), we                                      to publicly demonstrate our support for
   will best integrate ESG into both our                                      see that the application of responsible                                     the PRI, and that our participation will
   corporate operations and investment                                        investment, as described by the UNPRI,                                      significantly assist our ESG program.
   decision-making across asset classes.                                      will assist firms in adopting longer-term
                                                                              views, especially as asset owners, fund                                     We also continue to answer client
   We believe that now is a good time to                                      managers and brokers adopt a similarly                                      queries about ESG-related issues, and are
   promote ‘long-termism’ in investment                                       aligned outlook.                                                            currently completing a number of ESG
   management, with the global financial                                                                                                                   surveys that our clients have sent to us.
   crisis highlighting the failings of some                                   While it is not required in our first year                                   This is a great indication of the increasing
   short-term attitudes towards company                                       as a UNPRI signatory, QIC is currently                                      importance super funds are giving to the
   management, asset ownership and                                            completing the UNPRI 2009 annual survey.                                    incorporation of ESG considerations in
   investment management. As a relatively                                     This is because we think it is important                                    investment decision-making practices.



   Portfolio rebalancing – an old concept with significant benefits
   in volatile markets
   Troy Rieck, Managing Director, Capital                                     While rebalancing on a monthly basis is                                     A frequent rebalancing strategy also allows
   Markets, explains why.                                                     a strategy commonly used by funds, it                                       gradual buying as markets fall. This means
                                                                              ignores the fact that member cashflows                                       that purchases are undertaken at lower
   While the concept of rebalancing is not                                    take place on a daily basis, that markets                                   prices, improving the fund’s potential
   new, the extreme market volatility we                                      trade on a daily basis, and that the risks                                  future performance. It also mitigates the
   have recently experienced has highlighted                                  associated with asset allocation exist on                                   risk of having a large underweight position
   its importance, particularly in relation                                   a daily basis. This is especially true during                               in a volatile asset class just before markets
   to managing risk and ensuring funds                                        highly volatile market conditions.                                          bounce back.
   stay on track to achieve their long-term
   investment objectives.                                                     A frequent rebalancing strategy                                             Another important consideration is the
                                                                              (i.e. rebalancing on a daily basis) offers                                  rebalancing method. The most effective
   In the second half of 2008, the extreme                                    funds greater risk control and a superior                                   way to rebalance is through the use of
   volatility in global financial markets                                      risk-return tradeoff. Funds that employ                                     derivative contracts, as transaction costs
   meant daily movements of 5% to 8%                                          an infrequent rebalancing strategy may                                      are significantly lower and funds have more
   in sharemarkets and currencies were                                        need to rebalance at a time when liquidity                                  flexibility in managing their total effective
   common. In this environment, a portfolio’s                                 is thin or unavailable, as we saw in                                        exposures. On the downside, using
   asset exposures can drift significantly                                     September and October 2008. This may                                        derivatives may introduce counterparty
   from the desired position very quickly,                                    result in the inability to trade or may force                               risk; however, this can be managed
   increasing the risk of sub-optimal fund                                    trades to be undertaken at poor prices,                                     through the use of multiple, highly rated
   performance. Portfolio rebalancing                                         reducing the fund’s long-term returns.                                      counterparties and the use of exchange
   programs help manage this risk.                                            A frequent rebalancing strategy means                                       traded derivative where practical.
                                                                              that smaller volumes are traded, and
   By regularly rebalancing the portfolio                                     therefore funds are not as reliant on the                                   The benefits of rebalancing can vary
   to the desired weights, the investment                                     availability of market liquidity. In addition,                              from fund to fund; but, we do know that
   manager can maintain a high level of                                       if trading cannot be undertaken, the risk                                   a diversified fund will benefit from the
   control over the portfolio outcomes and                                    associated with the unbalanced positions                                    care and attention a frequent rebalancing
   keep the portfolio on track to meet the                                    held is smaller (because position sizes                                     program brings. To find out more about
   fund’s investment objectives.                                              tend to be much smaller when frequent                                       how rebalancing can help you manage
                                                                              rebalancing is undertaken).                                                 your portfolio risk, contact your QIC
                                                                                                                                                          Relationship Manager or download the full
                                                                                                                                                          Red Paper from the Knowledge Centre at
                                                                                                                                                          www.qic.com.



                Recycled paper used                           e     An environmentally responsible product

   Important information
   QIC Limited ACN 130 539 123(“QIC”) is a company government owned corporation constituted under the Queensland Investment Corporation Act 1991 (Qld). QIC is regulated by State Government legislation
   pertaining to government owned corporations in addition to the Corporations Act 2001 (“Corporations Act”). QIC does not hold an Australian financial services (“AFS”) licence and certain provisions (including the
   financial product disclosure provisions) of the Corporations Act do not apply to QIC. QIC, its subsidiaries, associated entities, their directors, employees and representatives (“the QIC Parties”) do not warrant the
   accuracy or completeness of the information contained in this document (“the Information”). To the extent permitted by law, the QIC Parties disclaim all responsibility and liability for any loss or damage of any nature
   whatsoever which may be suffered by any person directly or indirectly through relying on the Information, whether that loss or damage is caused by any fault or negligence of the QIC Parties or otherwise. The Information
   is not intended to constitute advice and persons should seek professional advice before relying on the Information.



Contact + 61 7 3360 3800 or email qic@qic.com                                                                                                                                                            www.qic.com

				
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